Financial education: Part 7 – what young adults should know
Sister site Muckle is passionate about long term savings and investment; where others sell ‘products’ Muckler seeks to engage and motivate people of all ages to connect with their finances and achieve better outcomes – whatever they aspire to. Financial education is the key to achieving FIRE – ‘Financially Independent, Retired Early’.
This is due in no small part to the fact that things in the future will look very different to how they were in the past; cradle to grave state support will necessarily be replaced by financial self-reliance.
Those clinging to the expectation of universal health care, later life care, a ‘living’ state pension etc, may have to face some unpleasant realities further down the line.
However, based on the fact that you can only start from where you are, everyone can make a positive difference to their financial outcomes; financial education is the key.
Likely to be in most need, because of their ability to invest over a long period of time, young people are also the most likely to benefit from engaging with their finances, and here we look at just a few things that they should know in order to make a difference.
‘young people are also the most likely to benefit from engaging with their finances’
Financial education in schools and colleges is improving but there’s a way to go, and social media is playing its part; whether you have just left school or further education, you will be facing critical and conflicting decisions about your wealth from the start.
The very thought of ‘wealth management’ can have some cringing and reaching for another energy drink, but whether you roll your sleeves up and immerse yourself in the process, or roll your eyes and find a very ‘light-touch’ solution, taking control of your financial future is not a spectator sport.
Once you have identified your goals and established that they are indeed worth achieving – ‘FIRE’ is increasingly quoted – it’s time to plot a course.
Time is on your side
The first experience young people have in managing money is usually through some kind of savings account and one of their first decisions to make as they start work is how much to save.
Although there are a number of savings apps that suggest how much you could afford to save, it is rarely a bad idea to try to add some science to the process; work out how much you could put away without leaving yourself exposed and try to establish a regular savings regime of that amount.
‘As much as possible’ is well-intended, but easy to interpret according to your mood of the moment; saving during your youth is also very important and saving over a time horizon that may span fifty years can make a dramatic difference.
In terms of accumulating long-term wealth, never again will it be so easy to build a life-altering nest egg from relatively modest contributions.
It’s a balance – pay off expensive debt
The cost of a university education has spiralled in recent years, and the fact that interest is applied to student loans at the rate of CPI + 3% – currently 6.3% – is punitive to the verge of cruelty.
It is a political hot potato, and a topic that is likely to be debated long and hard in the future, but the sad reality is that those that have been saddled with such huge debt are likely to have to carry it effectively as an additional tax on their journey because of the huge expense of writing them off. The loans will also have been sold on, so there is unlikely to even be any mild amelioration.
‘the fact that interest is applied to student loans at the rate of CPI + 3% – currently 6.3% – is punitive to the verge of cruelty’
Credit cards too have become increasingly easy to obtain and for many debt, especially high-interest obligations, can become a financial headwind for life if not responsibly managed.
We have been ‘spoiled’ with a long period of low interest rates, but any significant hike could cause real financial difficulty for those carrying variable debt obligations; at £200/month, it takes about 4.5 years and £10,600 to pay off a £10,000 loan at 3% interest. However, if interest rates were to hit 15%, that then looks like 6.5 years and £15,600.
Clearly it makes no sense to be saving as 2% or investing at 5% if you are paying interest on a loan at a higher rate, so how do you balance saving and paying off debt?
Here are some good rules of thumb:
If you have one, try to put as much as your employer will match into your company pension. This is essentially ‘free’ money and you’re leaving money on the table if you fail to get the ‘full’ amount.
Ideally avoid credit cards, but if you have credit card debt those double-digit interest rates are the most difficult to overcome, but try to pay them down.
Pay down other debt such as car loans.
Save to tax-efficient accounts such as ISAs before any other.
Buying a property
However remote the possibility may seem at the time, most young adults still say that they aspire to owning their own home.
With private rents high, shared tenancy is common and there is still a feeling that rent is ‘dead’ money.
At the moment, house prices have stagnated in many areas, and the likely effect of Brexit remains unknown; however, purely based on supply and demand, with an increasing population and lack of house building, prices are likely to continue to rise, ironically stoked by schemes such as help-to-buy and fractional ownership that were intended to improve the situation.
‘prices are likely to continue to rise, ironically stoked by schemes such as help-to-buy and fractional ownership that were intended to improve the situation’
In the States, young people are increasingly advised to postpone home ownership until they are in their mid 30s as both a financial and lifestyle decision; once you own your own home, you’re less mobile, which can lessen career opportunities, curtail new relationships or otherwise tie you prematurely to a particular lifestyle.
It could also mean that a young person with likely fewer financial assets, pouring the bulk of their wealth into a single asset is the cardinal ‘eggs in one basket’ sin of investors over exposed to one particular asset.
Taking a longer term view, gives young adults the chance to amass the 20% deposit they may require to get on the housing ladder if they are denied access to the Bank of Mum and Dad.
Schemes such as the Lifetime ISA may be attractive to some, and by taking a longer view, it may be appropriate to seek higher returns from riskier investments.
When you do take the plunge, make sure that you can manage the repayments on your loan should interest rates rise, or consider accepting a slightly higher rate in order to fix your loan for a longer term.
Insurance – the belt and braces?
Insurance is another wealth decision, and one that comes in many guises; generally speaking, the highest priority is to insure against applicable catastrophic losses, even those with low probability.
One thing is for sure ‘I don’t think you’ll really need that’ is not to be found in the insurance salesman’s lexicon, so you need to find appropriate cover for your individual circumstances.
E.g. it’s highly unlikely a young adult will die young, but if that were to happen, leaving a spouse and dependent children, the financial impact would be profound and the cost of insurance relatively modest.
On the other hand, if your smart phone breaks within a couple of years, you’ll find a way to replace it; insurance in the form of extended warranties is largely just a money maker for the vendor.
Investing for the Long Haul
Once a young person has established a rainy day fund – readily accessible cash to cope with any eventuality – it may be time to start an investment regime.
Having a nest egg in a secure savings account can deliver a tremendous sense of well-being but in the enduring low-interest environment, the likelihood is that the real value of any savings will be reduced every year; the rate of interest achieved is lower than the prevailing rate of inflation, eroding the buying power of every pound of savers’ cash.
‘You don’t see many advertisements for banks trumpeting the fact that every £1 you lodge with them now will be worth 98p in a year’s time!’
You don’t see many advertisements for banks trumpeting the fact that every £1 you lodge with them now will be worth 98p in a year’s time! (Nor that it might be worth £1.06 to them if they lend it to someone buying a home)
Investing a portion of your wealth into the stock or bond market, or a range of other assets where long-term market growth is expected helps you get ahead of inflation.
By investing, you’re able to at the very least preserve the purchasing power of your existing wealth, if not build more.
However, market investments are not insured or protected in the way savings are and you can lose part or all of your investments; this is where having even a rudimentary knowledge of the basics can be so important.
While investing is necessary and critical to wealth accumulation and management, the most important action you can take is to diversify your investments to protect yourself against market risk; making sure that as far as possible that if you are losing money when one market or sector goes down, you are invested in others that may be on the rise. Avoiding concentrated positions in individual securities – shares in one particular company – can spread your risk that the management may do a Ratner; OK, it was a long time ago, but still worth a look.
It always makes sense to try to keep your costs down, copious academic research has indicated that higher investment costs are not expected to lead to better or faster results; the more that is sacrificed to advice, trading costs, taxes and other expenses, the less you get to keep.
There are very many options for young adults seeking to invest and to a large degree the decision rests on how ‘hands on’ they want to be with their investments – from picking their own individual investments to allowing a robo advisor to take control – as Muckler says, often: ‘Do it Yourself, Do it With me, Do it For me – just don’t do nothing!’
‘Do it Yourself, Do it With me, Do it For me – just don’t do nothing!’
Regardless of how you access them – and there is plenty more information on this site – investment funds are a way to achieve an instantly diversified investment portfolio.
Funds basically pool your money with that of a large number of other investors and then buy a whole range of underlying investments – shares, bonds, other funds, commodities etc – in pursuit of its objectives.
‘Passively managed’ funds are ‘trackers’ or sometimes ‘Exchange Traded Funds (ETF)’ that in their simplest form buy fractions of all of the companies in a particular index, such as the FTSE 100, and give you an investment return in line with that.
‘Actively managed’ funds such as Unit Trusts or Investment Trusts set out to beat what is known as a ‘benchmark’, which could be the FTSE 100 performance, and deliver you a bigger profit in excahne for the typically higher cost of having a professional fund manager.
As you become more experienced and confident as an investor, and your circumstance and objectives change, so will your approach to investing; as a young adult you have the opportunity to take maximum advantage of Muckle’s founding principle – ‘mony a mickle maks a muckle’.
Many small things combined over a long period of time, create a big thing; savings and investment 101 – does what it says on the tin.
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